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for (our) ownership in Capline for (our) support in their obtaining ownership in such other pipelines as Olympic.

These candid statements, made by officials of these large petroleum companies, illustrate the most important problems in the pipeline industry: inadequate pipeline capacity and arbitrary denial of access. That the world's largest petroleum firms have problems using the nation's pipeline system merely suggests the degree of difficulty many small companies must experience. Unlike these larger firms, smaller firms realistically cannot buy into any pipeline that they want to use. Neither can a smaller firm offer to swap ownership support in order to get access to a line. A smaller shipper must be satisfied with having its business accepted only “if it is incrementally very profitable or if compensating adjustments are made. ..."

In the internal statements cited above, oil companies cited capacity problems. In addition, lack of adequate pipeline capacity has also disturbed officials concerned with assuring continued sufficient crude oil supplies for the refineries in the northern tier of the United States. Canadian officials are willing to permit northern tier refineries to use Canadian crude oil if the Canadian crude is exchanged for domestically produced crude. However, upon investigation, FEA officials discovered that “all critical pipelines out of major centers are full or otherwise not available for shipping crude to Canada.” 6

These capacity problems are not merely accidental: Major oil companies have an incentive to restrict capacity of their pipelines in order to maximize profits in downstream markets. To illustrate this point assume that Boston is served by one pipeline, that it is the leastcost method of transportation into Boston, and that it is owned by one firm. How large will the owner make the pipe? If the owner is a firm that depends upon the profit derived solely from pipeline transportation fees, it will size the line to maximize its transportation profits. On the other hand, if the line is owned by a firm that owns both the pipeline and sells gasoline in the Boston market, that firm will size the line so that the combined profits from the operation of the line and the gasoline sales in the Boston market are maximized. Under Federal regulation, the profit rate permitted on pipeline operations is fixed. However, the owner-shipper can size his line so that the volume of gasoline that flows into the market is restricted, thereby ensuring that profits from its gasoline marketing operations are maximized.

If the line is owned by more than one firm (a joint venture), the ownership group can size the line to maximize their joint profits. This profit-maximizing position will occur despite the regulation of pipeline rate of return and even assuming the absence of any barriers which bar access by non-owners. Barriers to access merely determine which shipper receives the profits, not the total amount of the profits.

The cost of alternative transportation systems sets the upper limit on the amount of profit that the pipeline's owners can make. If the pipeline cost is 50 cents per barrel and the corresponding tanker cost is 60 cents, shippers on the pipeline can reap 10 cents per barrel pure profit. In fact the persistence of a dual transportation system-one

61. at 90 fn.

• FEA. “Petroleum Supply Alternatives for the Northern Tier States Through 1980," June 1977 at 74.

low cost and one high cost—shows that the users of the least-cost system are making supra-competitive profits. Under such conditions, pipeline expansion is warranted so that those shippers who have been forced to use the higher-cost transportation can share in the benefits of the lower-cost system. However, this expansion is unlikely to occur as long as the pipeline owners have an incentive to forego increased pipeline revenues in order to capture monopoly profits downstream.

Moreover, it is not merely the interest of competitors which should concern us. The consumer always gets charged the price dictated by the marginal-cost mode, i.e. the highest-cost mode. Thus, if the additional 2,000 barrels per month needed to satisfy consumer demand is transported by higher cost tankers, the price charged by firms in the market for each barrel sold during the period would reflect the tanker price even if ninety percent of the month's requirements were shipped by the lower cost pipeline.

Pipelines are purportedly common carriers, and therefore it might be asked why these problems cannot be remedied through common carrier regulation. One would expect, for example, that as common carriers they would be required to maintain adequate capacity to serve the public need. I have suggested that major oil companies who own pipelines have an incentive to limit capacity. How are they able to do so consistent with their common carrier obligations?

The answer to this question is twofold: First, owners of joint venture pipelines have entered agreements among themselves which impede expansion of capacity and second, legislation concerning pipeline regulation does not give the Department of Energy authority to order pipeline expansion or to set pipeline capacity.

An example of how petroleum companies structure their agreements to inhibit capacity expansion is contained in the shareholders' agreements which were submitted to the Secretary of Transportation by the owners of LOOP, Inc. and Seadock Inc., two oil company consortia organized to construct, own and operate supertanker ports under provisions of the Deepwater Port Act of 1974. We believe that the provisions contained in shareholders' agreements for LOOP and Seadock are similar to, though possibly less restrictive than, many joint venture pipeline agreements.

First, the shareholders' agreements permitted the owners of a minority of the outstanding stock to block expansion by refusing to approve the creation of indebtedness needed to finance such expansion. The LOOP agreement provided that any two or more shareholders that together owned more than 25 percent of the outstanding stock could have disapproved the creation of long-term debt. Any two or more Seadock holders owning more than 30 percent could block Seadock's expansion. Because of the overlapping ownership proposed for Seadock and LOOP, three companies, based upon estimated ownership percentages, would have been able to block expansion of both of the ports.

A second common device for ensuring close control over expansion is the agreement provisions that prevent shareholders from selling shares of stock to third parties without giving other shareholders a series of options to purchase the shares.

A third limitation on likely expansion is the policy of single-time ownership recomputation. Thus, ownership shares are frozen after a given period of time, often after 5 years. This means that if an owner overships his share after the fifth year he pays for such overshipment at effectively the full tariff rate with no commensurate increase in his share of the pipeline profits. This tends to stabilize market shares.

Finally, the almost universal adherence to throughout and deficiency agreements as the accepted means of pipeline financing ensures that non-petroleum companies, who presumably have an interest in the operation of a pipeline qua pipeline but can offer no throughout commitment will not become pipeline owners.

By these multiple devices, pipeline owners are able to size their line conservatively and insure against expansion that would disrupt market stability.

Under current legislation, Federal authorities are powerless to order capacity expansion. Unlike other common carriers and public utilities, pipelines are not required to secure a certificate of convenience and necessity as a condition of operation. Thus, Federal regulatory officials have no control over a pipeline's size or routing. While, if there were no economies of scale in pipeline transportation, a competing pipeline could be constructed to take up the capacity not served by the existing carrier, the existence of these economies makes it very unlikely that such a line would be viable if it were built to meet only an incremental share of total demand.

The degree to which a pipeline owner is able to capture the monopoly rents available to it through its transportation cost advantage depends upon the extent to which the owner is able to preserve to itself available space on the pipeline. Complete denial of access to nonowners, while appealing, is not a necessary ingredient in the formula.

Control of pipelines by major integrated oil companies, however, has substantial distorting effects on competition in the petroleum industry beyond the pipeline's role as a vehicle for capturing monopoly profits.

Oil company owned pipelines, particularly joint venture lines, provide a ready vehicle for coordination of competitive activity and for monitoring the activities of independent shippers. While the Interstate Commerce Act prohibits a carrier from disclosing confidential shipper information without the shipper's consent (49 U.S.C. section 15 (13)), it does not prevent the owners of a line from voluntarily sharing such information through the pipeline to coordinate their supply and distribution activities. Notably, pipeline tariffs frequently require crude oil shippers to authorize release of their shipment information for purposes of gravity and sulfur differential adjustments. This information may subsequently be reported by the pipelines through their gravity banks to all shippers on the line.

As I have discussed. reliable access to crude oil supplies and to markets for petroleum products is predicated upon access to oil pipelines. Refinery investment and market expansion, in turn, are dependent upon assured availability of transportation services. While common carrier regulation can do much to curtail the most flagrant discriminations against outside shippers. it cannot address the inherent inconsistency between a pipeline's common carrier responsibilities and its raison d'être: Service to its parent shipper. From their design and

placement through to their day-to-day operations, pipelines are intended by their owners to serve solely the needs of their owners. While independents may demand access to a pipeline, their needs play no part in determining where a pipeline should be built, what markets it should serve, what its capacity should be, what storage and terminal facilities it should provide, or what its operating rules and regulations should be. As long as the pipeline does not discriminate between shippers who, despite these obstacles, have gained access to the line, the pipeline satisfies its limited common carrier obligations. The fact that its tariff regulations, placement, capacity, and lack of storage and terminal facilities, may in themselves make the line inaccessable to independent refiners and marketers is irrelevant.

Licensing and tighter regulation of pipelines may reduce existing abuses of pipelines but they cannot create the competitive incentives necessary for growth and development of a transportation industry responsive to market demand, the transportation needs of the petroleum industry as a whole (rather than only that of the select owners), and the petroleum supply requirements of our country. Freeing pipelines from the control of their owner-shippers can provide such incentives. Most importantly, it can do so without substituting the judgment of Government regulators for that of the business community.


On behalf of Secretary Brock Adams, I would like to thank this subcommittee for inviting the Department of Transportation to provide our experience and observations concerning the question of pipeline ownership by integrated oil

companies. The main involvement of the Department in the economic regulatory matters of oil pipelines has been in relation to the applications to the Department for deepwater port licenses under the Deepwater Port Act of 1974 (“Act”), Public Law 93–627, 33 U.S.C. section 1501, et seq. As you know, a deepwater port is an offshore facility at which an oil tanker can moor for the purpose of unloading its oil. The oil goes by submarine pipeline onto shore for storage and distribution to refineries throughout the country. When such a port is located far enough offshoro that the water is 90–100 feet deep, very large crude carriers (VLCCs) will be able to use the port and bring their oil directly to the U.S. Presently, our ports can only accommodate smaller vessels, which means that either the entire voyage is by smaller vessel, or the oil is transferred at some point by lightering or transshipment from VLCCs to smaller vessels. The Deepwater Port Act was enacted for the purpose of permitting the U.S. to receive oil directly from VLCCs, which would allow the Nation to take advantage of the environmental and safety benefits, and the transportation economies of scale, of VLCCs.

The Act established this Department as the licensing agency for deepwater ports. In order to provide a "one-window" application procedure while assuring that all appropriate agencies have input into the process, the Department, rather than the license applicant, is required by the Act to seek the advice of several agencies. Inasmuch as the Department must make the final licensing decision in each instance, the Act required the Department to consider, among other things, the economic regulatory aspects of deepwater ports. This is the first statutorily required involvement by the Department in the economicas opposed to safety-regulatory affairs of pipelines.

The problems presented by oil company ownership of deepwater ports and by oil company ownership of pipelines generally are similar in certain respects because of the inherent competitive advantage for owners who ship their own oil; because deepwater ports and pipelines are a natural monopoly; because deepwater ports and pipelines which are jointly owned by several oil companies present the potential for oligopolistic abuses. Consequently, the experience of this Department in relation to the deepwater port applications by integrated oil companies might be informative to this subcommittee in its consideration of the problems presented by oil company ownership of pipelines.

In the development of the Act, there was considerable pressure to exclude oil companies from deepwater port ownership. However, the countervailing concern was expressed that no entity other than oil


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